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Borrowing money against your home's equity can pay for the kitchen remodel you've always dreamed of, or it may be used to send your child off to college. Home equity loans have very few limitations on how you utilize the funds. However, because a home equity loan puts up your home as collateral, you'll want to use yours wisely and repay it on time.

What is Home Equity?

Home equity is the difference between the appraisal value of your home and the amount you have left to pay on your mortgage.

For example, if you own a home that's worth $280,000, of which you still owe $100,000, this means you have equity of $180,000. A home equity loan may let you borrow up to 85 percent of your home's equity value, or $153,000.

Equity is one reason why it pays to continuously upgrade your home with simple fixes, such as energy-saving windows and doors, highly-efficiency systems, and the latest fixtures. These upgrades increase your home's resale value. So, even if you don't have the intention of one day selling your home, you're still actively increasing its equity value.

How Does a Home Equity Loan Work?

When you take out a home equity loan, you're essentially taking out a second mortgage on your home. Your lender uses your home as collateral to lend you a lump sum of money which most borrowers then use for major expenses such as college tuition, a dream vacation, or home renovations.

As long as you qualify for the loan, you can use the funds for anything you choose. You must repay the loan on time, according to the terms of the loan, to avoid foreclosure.

What is a Home Equity Line of Credit?

A home equity line of credit (HELOC) is similar to an equity loan because it still allows you to borrow against your home's appraisal value.

However, using a line of credit, you can borrow smaller amounts when needed by writing a check or using a credit card linked to the account. HELOCs are revolving lines of credit, meaning you can borrow from the account over and over again as you make payments, as long as you don't exceed your credit limit.

Are Home Equity Loans Superior to Personal Loans?

Home equity loans have both advantages and disadvantages over personal loans, the biggest difference being that, with a home equity loan, your home is the collateral. If you're unable to repay it on time, you risk forfeiting your home.

On the other hand, the interest and fees associated with home equity loans are usually lower than that of other loans, including those drawn on a personal line of credit. This means the loan essentially costs less over time.

Can Your Home Equity Change Over Time?

Home equity will change over time for several reasons, including:

  • You've made more payments on your home, meaning you owe less.
  • The housing market has gone up or down.
  • You've improved your home and boosted your equity.
  • You've allowed your home to fall into disrepair and decreased your equity.
  • Housing prices have gone up or down in your neighborhood.

Events beyond your control may also change the appraisal value of your home.

For instance, your equity could go down if the city builds a busy intersection outside your back door. Or, it could go up as the homes around you improve. Many things affect the value of your home, but the biggest factor is usually how well you maintain it, and how well the homes around you are maintained.

Is There a Better Time to Take Out a Home Equity Loan?

The best time to take out a home equity loan or line of credit is when you can repay it. You should also check the status of your credit before applying. A higher credit score will net you better repayment terms, such as lower interest rates.

Be sure to approach only reputable lenders whose reputations are apparent, and make sure you understand the fees and repayment schedule of any loan for which you sign. Your local credit union is a great place to start.

Knowing When & How To Use Home Equity

A home equity loan or line of credit is a solid way to fund major purchases that you would otherwise be unable to afford.

As long as you act responsibly and take only as much money as you can afford to repay, there's no reason not to consider this type of loan. And when you shop around to find the best terms and conditions for your loan, you can score much better deals than you would on a personal loan.

If you're considering a home equity home or line of credit, reach out to us, we have answers to all of your questions regarding the best way to cash in on your home's equity.

More About Home Equity Loans